The self-reinforcing cycle in which falling prices reduce spending, leading to lower demand and output, higher unemployment, and further price falls is called what?

• A. Cyclical unemployment
• B. Deflationary spiral
• C. Stagflation
• D. Inflationary gap

Answer: (B)

This describes a deflationary spiral. When prices are falling, people and firms often expect prices to drop further, so they cut back on spending and investment now. With demand weak, firms reduce production and lay off workers, lifting unemployment. With higher unemployment and weaker income, overall spending falls even more, pulling prices down again. The cycle can be intensified by debt deflation, where falling prices raise the real burden of existing debt and lead to further deleveraging and cutbacks. The other options fit different situations—cyclical unemployment is about job losses in a downturn, stagflation combines stagnation with rising prices, and an inflationary gap involves demand pushing prices up—so they don’t describe this downward price–output spiral.